If you have much credit card debt, and if you are struggling to make your payments on time, you should be paying close attention to announcements from the Federal Reserve. Most of the experts who watch “the Fed” say it will raise interest rates sometime during the coming months. Interest rates have been at historic lows, and the next raise will be the first in several years. The initial rate hike is not likely to be dramatic. Ordinarily, the Fed raises interest rates in several small increments, not one big leap. For example, Megan Greene, managing director and chief economist at Manulife Asset Management, was recently interviewed on National Public Radio. She said,
“I think we’ll see a very slow and episodic hike in rates… we’ll see the Fed hike rates by 25 basis points then wait a couple of months, see what the impact is on the real economy, maybe hike another 25 basis points.”
Twenty five basis points translates into a one quarter percent rise in interest rates. By itself, this is not a big change, but it is likely to be followed by several more quarter percent raises. In a year, give or take a couple of months, rates could move one, two, even three percent higher.
Because we are now at historically low interest rates, the rate increase we are considering would only put us back into a range of interest rates that would be “average.” For consumers who have a lot of credit card debt and other short term variable interest debt this is not much comfort. Any of us in that place are more concerned with the fact that rates are going up and our payments will increase. We care about the money in our wallets, not the history of interest rates.
As Ms. Greene put it in her interview with NPR,
“when rates start going up, people will have a harder time servicing their debts. So some borrowers will have an even harder time than others because some debt is pegged to short-term rates, which are very closely linked to the Fed’s rates.”
Two things that are tied to short term rates are credit cards and variable interest rates. Credit card rates are directly connected to short term rates set by the Fed. They will rise faster than almost any other consumer charge. Variable interest mortgages will take a little longer to show the effects, but in a few months your mortgage payment could jump noticeably higher. The combination of higher credit card payments and mortgage payment might even make our homes unaffordable.
Common sense tells us that we should be preparing for the coming rate hikes by doing two things. First, we need to start paying down our credit card debt as quickly as possible. Get disciplined, stop using the cards, make the largest payments possible and get the balance owed on your cards down. Way down. Next, look for a good mortgage lender and refinance your home. Get rid of the variable interest loan and take a fixed rate mortgage. The fixed rate means the payment is always the same, always predictable, something we can depend on no matter how high interest rates climb.
A raise of two percent in the interest rate may not seem like much, but even a small change can make big difference in your finances. On a hundred thousand dollar mortgage loan, a change from 4.5 to 6.5 percent interest will increase the loan payment more than one hundred dollars per month. Combine that with higher payments on credit card debt, and the total increase can be more than your monthly budget can bear.
It’s your money and your budget. With a little planning and preparation, it can be a lot easier to manage.